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Sitting Out the Roth IRA Movement Party

posted on March 27, 2012

I woke up this morning hearing there’s a Roth IRA Movement going on in the bloggers circle.

I don’t have anything prepared, except I want to remind everyone not to forget The Forgotten Deductible IRA. Roth IRA is great if you aren’t eligible for a tax deduction for contributing to a traditional IRA, meaning

you earn more than $66,000 (single) or $110,000 (married filing jointly) in 2011 in adjusted gross income ($68k and $112k respectively in 2012) AND

you are covered by a retirement plan at work

Most people aren’t like that. 40% of workers don’t have a retirement plan at work. Last I heard the median household income is around $50k. $66k single and $110k married are way above median.

If you aren’t there yet or if you or your spouse don’t have a retirement plan at work, don’t forget the deductible IRA.

For those determined to use the Roth IRA and let go the tax deduction, there is a better way to do it. It’s called Deduct-and-Convert. If you live in the right states, you can save hundreds of dollars in state income tax on Roth IRA contributions.

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Comments

I’m amazed that the affection of the personal finance blogsphere for Roth IRAs has remained this strong after so many years… it makes me really miss the badmoneyadvice.com blog :-(. The cynic in me wonders if these other personal finance blogs are written by members of Congress to secretly increase tax revenue in the short term.

Full disclosure: I do contribute to a Roth IRA seemingly in violation of your blog post today, but since I make a large enough traditional 401k contribution to knock me out of the 25% tax bracket I believe I’m still in compliance with TFB’s overall advice ;-).

It’s always important to evaluate whether paying taxes now or later makes sense, but all things being equal, the Roth IRA is far superior to the traditional for many reasons:

1) You can shelter more money. $5K after-tax > $5K pre-tax
2) No RMDs
3) Stretch Roth IRA saves heirs a great deal
4) Backdoor Roth available to hirer earners, traditional roth isn’t
5) Contributions can be taken out tax and penalty free- can serve as an e-fund.

@David C – Same here. badmoneyadvice.com blog is still there. I still have it in my RSS reader hoping he will come back. We just need to petition Frank back to moonlighting although he has a lucrative job. I don’t know how he could quit just like that. I’m too addicted.

@White Coat Investor – That’s the thing. All things are never equal. Every point you raised has a remedy in traditional IRA.

1) Additional money can be placed in 401k. 90% of people don’t max out.
2) RMDs are not a problem for 90% because they want to withdraw for income anyway.
3) Stretch isn’t an issue because most don’t even have enough retirement savings for themselves if you believe the numerous studies.
4) Backdoor Roth starts with contributing to a traditional IRA!
5) Contributions withdrawn can’t be put back. Use a retirement account for retirement!

@White Coat Investor
I guess it’s just a matter of perspective. Your points (which are valid and I have seen them before on this blog and elsewhere 🙂 ) *are* real advantages in favor of Roth contributions but they primarily benefit those with higher incomes (I don’t want to say “rich” because “rich” equates to Richie Rich or Scrooge McDuck to me 😉 ). So I don’t have a problem with your blog or TFB’s mentioning those advantages since I suspect your blog audiences have above average (and higher) incomes… and also understand concepts such as the commutative property of multiplication :-).

These other blogs however… they seem more geared for the average worker (nothing wrong with that, I’m either average or barely above average myself) which makes the idolization of Roth IRAs there so odd to me (a skeptical blog such as JoeTaxpayer seems to be the exception rather than the rule). Worse, some of these other blogs do not provide any real reasons for preferring Roth contributions over traditional: emotional arguments such as “but a Roth IRA is ‘tax-free’ yippee!” seem to rule the day :-|.

TFB, do you only hold stocks in your retirement accounts? I don’t think you do, so why would you recommend anyone holding only pre-tax retirement accounts? It’s just as important to diversify your retirement accounts with stocks/bonds as it is to diversify your accounts from a tax perspective.

I’m not sure if you are advocating no contribution to a Roth IRA or just not the maximum 5k. But I like a 2:1 ratio of pre-tax to after-tax reitrement contributions.

May I ask why it’s just as important to diversify the pre-tax/post-tax status as it is to diversify between stocks and bonds? How do you measure importance anyway? Why isn’t it half as important or 10% or 1% as important? Let’s have some supporting evidence please.

If it’s supposed to be 2:1 pre-tax to after-tax, where is the Deductible IRA Movement? Why start with the 1/3 not the 2/3?

The answer to the Roth IRA movement is the not an anti-ROTH IRA movement.

The value of the ROTH IRA really depends on current and future tax rate. If current taxes are low (not hard with a below median income) with some pre-tax contributions, the ROTH becomes much more valuable—especially for high savings-rate individuals.

As White Coat Investor says, the ROTH IRA is much more flexible when it comes to withdrawals. Facing an unknown future, that is very good in my opinion. It is even better when the present tax hit is bearable.

Unfortunately, due to complexity of the tax code and disparate income situations, it is hard to give specific universal advice. You do a good job of explaining these complexities. Keep up the good work.

Just to be clear, there is no anti-Roth IRA Movement. Saving for retirement beats not saving for retirement, however one saves for retirement. Roth IRA is one of the means to that end. There are also other means to the same end. Just like hammer, drill, and saw are all tools. They are good for different jobs. We shouldn’t overemphasize one tool and overlook the other tools.

If we are talking about a college student with a part-time job who will graduate to take a high-paying job, do the Roth IRA. If we are talking about a call center worker facing the threat of offshoring, the answer may very well be traditional even if the present tax hit is bearable.

I am a big fan of Roth IRAs, just because they are simple. I had a hybrid IRA (traditional with after tax contributions). I converted it just so heirs or I can have affairs simple in the future. This may not been the best strategy financially, but so far it has turned out well with taxes. Due to a conversion from a 401K to an IRA I will not be doing more conversions to Roth IRAs.

“Roths are really there for the big hitters — not for the common schlep who is going to have a hard time funding the IRA,” says John Buckley, former chief Democratic counsel to the House Ways and Means Committee, who is now a visiting professor at Georgetown University.

What’s more, [economist and FORBES contributor Leonard Burman] notes, the people for whom a Roth is the best deal are those who really don’t need the savings for retirement–they’re the ones who plan to leave these tax-free accounts to their kids.

Most people are not good candidates for a Roth account. However, most people are not reading this blog, so that’s probably a wash.

As long as we have a progressive tax system, Roth accounts are probably going to be a poor default choice. You need an exception to the rule. Examples:
1) You are maxing out tax advantaged accounts available to you:
a) including 401k, sep IRA, deductible traditional IRA, HSA, and any other tax-deferred accounts
b) You can only contribute to an IRA, be it deductible or Roth, but have more than $5000 to contribute. In this case the fact that the limit is $5k either way means you can effectively shelter more money in a Roth
2) Your tax rate is “artificially” low now
a) student, doctor in residency program
b) parents gifting their minor children money for a Roth contribution, matching their earned income (e.g. from summer and part time jobs)

Thanks for the article, David C. I always suspected that the Roth was an accounting trick.

None of us should be surprised by the politicians coming up with and expanding the Roth concept; after all, in 40 years when the missing tax revenues become a problem, today’s politicians won’t be the ones trying to get themselves reelected.

Like F.A.f.Y.P., I personally aim for 2:1 deferred:roth ratio. No math behind it, just my best guess.

Some food for thought: If the U.S. implements a value-added tax (or fair tax) – which appears to be increasingly likely – all the Roth strategies will be for naught as Federal Taxation will be based on purchases/spending. As such, money coming from a Roth would be taxed the same as money coming from a Traditional IRA.

Thanks for continuing to remind folks of the forgotten TIRA. Two supporting, personal examples:

1. My step father contributed only to a TIRA, all pre-tax. No 401k or any other retirement plan. At 80+, he is taking RMDs. He paid no income taxes the last two years, and is paying about a hundred bucks this year. With very healthy SS income, most living expenses are met with SS, RMDs and investment income. Tax savings at 25% or higher federal and CA top state rates (currently over 9%) going in, tax-free coming out.

2. A friend had been contributing to Roth IRA. His reason: “it’s tax free!”. Age 50+, and with very little saved (no 401k/403b), it’s likely that he’ll pay no taxes on TIRA withdrawals. It was hard to get him to understand this, since the mantra of “tax free Roth” had been drilled into him. He finally got it, and has switched over to TIRA contributions.

The mantra of “roth is better” is way overblown. You must look at your own situation to determine which is better. Roth definitely is much better for some, the only choice for others (via direct or backdoor), but definitely not the best for many.

@Mike: don’t forget as someone else commented Roth IRA distribution and inheritance features. So while a VAT might happen, Roth IRAs still have their advantages. IMHO you would be foolish not to have some of your portfolio that is Roth IRA based.

We need diversification not with just investments, but investment vehicles. With our government who the hell knows will happen and what stupid changes they will make.

I for example plan on creating a SEP IRA, or solo 401k within my company next year to minimize taxes (I currently don’t have one myself). This year I’m planning on taking out as much taxable income I can do since it will be at a lower rate than next.

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